GREAT insights Magazine

Debt Relief as a Development Tool

The Role of the Paris Club

January 2013

Kaiser, J. 2013. Thirty years after the outbreak of the Third World debt crisis: The need for a new deal on debt. GREAT Insights, Volume 2, Issue 1. January 2013. Maastricht: ECDPM

Debt relief granted by creditor countries to highly indebted countries significantly contributes to these countries’ development needs, by providing regular and foreseeable fiscal space. For instance, in the framework of the HIPC initiative, funds initially due to be spent on external debt service to creditor countries can be redirected towards an increase in poverty-reduction spending.

More importantly, using the extra fiscal space to fund development needs makes it is easier for countries to schedule poverty-reduction expenditures over the medium or long run (for example, for health or education programs over several years) than if they were to rely solely on grants, which are generally provided on an annual basis or in an even more unpredictable manner. Moreover, debt relief contributes to reestablishing external public debt sustainability which, in turn, allows countries to regain access to market financing through loans, provided that new debt increase remains sustainable.

In order to provide such debt relief, 19 creditor countries gathered to form theParis Club, an informal group of official creditors representing sovereign states and whose role is to find coordinated and sustainable solutions to payment difficulties experienced by debtor countries. As debtor countries undertake reforms to stabilize and restore their macroeconomic and financial situation, Paris Club creditors provide appropriate debt treatments, through debt rescheduling, i.e. debt relief by postponement or, in the case of concessional rescheduling, through a reduction in debt service obligations during a defined period (flow treatment), or through a reduction of the debt stock as of a set date (haircut, or stock treatment).

Debt relief granted by the Paris Club relies on standard terms of treatment associated with eligibility conditions that have changed over the years. For the poorest countries, the Paris Club’s terms have been increasingly generous. At the end of the nineteen-nineties, the international community acknowledged that the external debt situation of a number of low-income countries could only be resolved in a comprehensive way, including action by multilateral creditors which had been, until then, protected by their preferred creditor status. The Initiative for “Heavily Indebted Poor Countries” (HIPC Initiative) was launched in 1996 at the G7 summit in Lyon and reinforced in 1999. Its launch showed the willingness of the international financial community to tackle, in a comprehensive manner, the external public debt unsustainability of a number of low-income countries. All Paris Club creditors have moreover announced that they would provide debt forgiveness over and above the HIPC Initiative assistance, up to a full cancellation of claims.

Since the start of the HIPC initiative, debt relief granted to the 36 post-decision point countries at end-2011 amounts to almost 35 percent of these countries’ 2010 GDP, around USD 128 bn in nominal terms. The total debt relief effort provided under the HIPC initiative is shared by multilateral creditors (44,5%), the Paris Club (36,3%), non-Paris Club bilateral creditors (13,1%) and private creditors (6,1%). Hence, the HIPC initiative represents a genuine and significant financial effort from Paris Club member countries, especially considering that they indirectly contribute to debt relief granted by multilateral creditors, as they are major shareholders of these international financial institutions.

According to the IMF and the World Bank, debt relief granted since the beginning of the HIPC Initiative reduced beneficiary countries’ debt burden by about 90 percent relative to pre-decision point levels. Debt relief has also allowed beneficiary countries to reduce their debt service and to increase social spending. According to the IMF and the World Bank, for the 36 post-decision point countries, poverty reducing spending increased by more than 3 percentage points of GDP, on average, between 2001 and 2010, while debt service payments declined by a similar amount. Such progress is consistent with the HIPC initiative’ objective, namely, to reallocate the increased spending capacity towards the fight against poverty and to accelerate progress toward the United Nations Millennium Development Goals.

Apart from the HIPC initiative, the Paris Club adopted a new framework for debt restructuring in 2003,the Evian approach. Through the Evian framework, the Paris Club’s goal is to take into account debt sustainability considerations, to adapt its response to the financial situation of debtor countries, and to contribute to current efforts to ensure an orderly, timely and predictable resolution of economic and financial crises. The approach aims at providing a tailored response to debtor countries’ payment difficulties. Countries with unsustainable debt may be granted a comprehensive debt treatment, provided that they are committed to policies that will secure an exit from the Paris Club process, in the framework of their IMF arrangements.

Clotilde L’Angevin is head of the International Debt division at the French Treasury and Secretary General of the Paris Club.